EKIP– Expert Club for Economics and Politics A Different Opinion
After telling you in the first part of the series of articles on the bubbled recovery of the global economy how the loose monetary policy of major central banks creates the false impression that some of the major economies are on the path to recovery, in the second part I will focus on one specific bubble that manages to mask the negative consequences of government intervention.
The UK is one of the countries where the years before the Great Recession were accompanied by a real estate bubble (see Chart 1). The reasons for this are now clear: loose monetary policy (intervention in the market determining the price of a mortgage loan by the central bank), government intervention through various programs to stimulate home purchases, increased demand for “social” housing due to the ever-increasing nanny state in the UK, as well as the typical Anglo-Saxon desire for everyone to own their own home. Rising house prices, in turn, are one of the main drivers of the excessive growth of consumption in the years before the crisis due to the so-called wealth effect, according to which the more the price of assets owned by a given economic entity increases, the more its consumption increases due to expectations that the price will continue its upward trend in the future, increasing the net wealth of this entity.
Graphics 1
After the UK property bubble burst in 2007, the government and the central bank took a number of measures to limit the fall in house prices (and thus limit the negative consequences of reduced consumption due to the aforementioned wealth effect) and to help thousands of Britons continue to service their mortgage loans and thus not be left on the street. The Bank of England reduced its main interest rate from 5.75% in July 2007 to 0.5% in March 2009 - a level at which the benchmark remains to this day. In addition, the central bank undertook quantitative easing, asset purchases from commercial banks in order to improve liquidity and aimed at increasing lending, the amount of which has reached 375 billion pounds to date. On the legislative side, the government launched the Help-to-Buy scheme, which has a budget of 130 billion pounds. pounds and aims to help homebuyers by providing interest-free loans of 20% of the value of the home and government guarantees when taking out a mortgage loan.
The first signs of a renewed inflation of property prices in the UK are already visible. In July 2013, house prices reached a 5-year high in the context of a stagnant economy (GDP is still below its peak in 2008), negative real wage growth over the past five years (see Chart 2), a deteriorating labour market and high household debt levels (around 100% of GDP).
Graphics 2
The intervention in the mortgage market by the government and the central bank has brought down the interest rates on these instruments to record lows. It is hard to imagine that in the current situation, the risk (measured by the interest rate on mortgage loans) is lower than it was 6-7 years ago, for example. “Thanks” to the intervention, however, the price of these loans is lowered below the market price, which leads to excessive demand, and the presence of moral hazard makes banks careless, knowing that in case of liquidity problems their friends in parliament will bail them out with taxpayers’ money.
The inflating bubble in UK house prices is one of many examples of the global economic recovery being bubbled up. It is hard to even say there is any recovery in the UK, given that GDP is expected to grow by just over 1% this year.
This year, which is within the statistical error. State intervention in the British economy has already reached levels of 50% of GDP, up from a modest 34% in 1989, towards the end of Thatcher’s rule. These two indicators alone clearly point to the growing welfare state over the past little more than 20 years, leading to the stifling of private business, inefficient spending of limited resources and the rise of crony capitalism.
